Paper

Collateral and Lending to Rural Households in Emerging Markets

Making collateral-free loans viable
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This paper examines the use of collateral in the rural credit markets of emerging countries.

Collateral is an important instrument for formal lending institutions. It serves to limit potential losses to the lenders in case of loan defaults and reduces borrowers’ incentives to default. But poor people do not have the means to provide collateral.

This paper analyzes the way borrowers and lenders deal with this problem by examining data from North-Eastern Thailand. Findings include:

  • Conventional collateral is rarely used in rural credit markets;
  • Most loans are provided without any tangible assets as collateral;
  • Lack of assets does not seem to exclude the poor from credit access, because they do not have a higher probability of credit rationing than the rich;
  • Lenders in rural credit markets can enforce collateral-free loans through third party guarantees and the borrower-lender relationship;
  • Collateral is also substituted by reducing loan size and duration and increasing the interest rate;
  • There is no significant impact of the borrower’s wealth, savings and default risk on the use of collateral;
  • Use of collateral can be substituted by appropriate loan terms.

About this Publication

By Menkhoff, L., Neuberger, D. & Ungruxsirivorn, O.
Published